Explore Different Ways to Pay for Home Renovations

If it's time to finally replace your roof or maybe you're just ready to spruce up your kitchen, you might be wondering how to pay for such a large expense. Not every homeowner has thousands of dollars set aside for home renovations. Enter: home improvement loans.

A home improvement loan is a popular way to finance home renovations, and there are a variety of options you can look into to find the best fit for your needs. In this guide, we'll help you understand the different types of home improvement loans, their pros and cons, and typical qualifying requirements.

How Do Home Improvement Loans Work?

Home improvement loans are often unsecured personal loans that don't use your home as collateral. However, other home improvement financing options, such as cash out refinances and home equity lines of credit (HELOCs), do require your home to serve as collateral but almost always offer lower rates and fees because they carry less risk than unsecured loans.

Common Uses for a Home Improvement Loan

Common home improvement projects include renovating kitchens and bathrooms, finishing basements and attics, adding a deck or patio, building a garage, and making major repairs to roofs, foundations, HVAC systems, and plumbing and electrical systems. People typically use home improvement loans for large, expensive projects.

You usually aren't required to use the funds just on home renovations—you might decide to use a portion of the cash to consolidate debt, pay for college, or start a business.

Types of Home Improvement Loans

Home improvement loans come in several forms, each with different requirements, benefits, and risks:

• Cash out refinance: A cash out refinance replaces your current mortgage with a new mortgage of a larger loan amount, and you get the difference between those amounts in cash when the loan closes for home improvement projects or other expenses. Cash out refinancing almost always has the lowest rates of home improvement loans.
• Home equity loan: Home equity loans are second mortgages, based on the value of your home's equity. Similar to a cash out refinance, you'll receive a lump sum of money when the loan closes, and you can use that money to finance your home renovation.
• Home equity line of credit (HELOC): A HELOC is a credit line that's based on the value of your home equity. You can get cash from this line of credit for your home improvement projects as a lump sum or in several withdrawals over time.
• Personal loans and credit cards: You can also make home improvements with loans that aren't secured by the value of your home. These loans may have higher interest rates and different financial requirements than loans secured by your home.
• VA renovation loans: Eligible veterans, service members, and surviving spouses can use these to finance a home purchase or refinance, along with approved home improvements, in a single loan. Because the Department of Veterans Affairs backs them, they may offer competitive rates and flexible qualification requirements. The money borrowed must be used for renovations (unlike HELOCs or home equity loans).
• FHA 203(k) loans: The Federal Housing Administration's 203(k) loan program helps homebuyers finance the purchase of a home and pay for repairs. Homeowners can also get financing for home rehabilitation. You can learn more about the 203(k) rehab program here.
• USDA renovation loans: Eligible borrowers in designated rural areas can finance certain repairs or improvements in addition to their home purchase or refinance with this type of loan. Backed by the U.S. Department of Agriculture, these loans may offer low interest rates and no down payment for qualified applicants.

Home Improvement Loan Requirements

Lenders evaluate several factors when determining your eligibility for a home improvement loan, including your credit score, debt-to-income ratio, and how much equity you have in your home.

Credit Score

Lenders may have differing credit score guidelines for cash out refinances, home equity loans, HELOCs, and personal loans. Personal loans and credit cards often require a higher credit score because they don't use collateral (like your home) to secure the loan.

At Freedom Mortgage, we often accept a minimum credit score of 620 for cash out refinances using a conventional loan. For cash out refinancing with VA and FHA loans, we can often accept a minimum credit score of 550. If you're a Freedom Mortgage customer, primary borrowers can check their credit score on our mobile app.

Debt-to-Income Ratio (DTI)

Your debt-to-income ratio (DTI) compares your total monthly debt payments to your gross monthly income. Lenders use this percentage to verify your ability to manage additional debt.

A lower DTI improves your chances of approval and may help you qualify for better rates and loan terms. While requirements vary by lender and loan type, many home improvement loans prefer a DTI between 36% and 43% (or lower), though some programs may allow higher ratios for qualified borrowers.

Home Equity

If you're financing improvements with a cash out refinance, home equity loan, or HELOC, you should also consider how much equity you have in your home. You'll often need at least 20% equity in your home to qualify for a mortgage-backed home improvement loan. You typically can't borrow the full value of your home equity, so it's important to estimate whether the amount will cover the home improvement projects you have in mind.

Pros and Cons of Home Improvement Loans

Home improvement loans can help you finance renovations without paying a lot of out-of-pocket costs upfront, but the right option depends on your financial situation, equity, and long-term goals.

Home Improvement Loan Benefits

• Access to large loan amounts: Secured loans based on home equity may allow you to borrow more than unsecured options.
• Competitive interest rates: Mortgage-backed loans almost always offer lower rates than credit cards or personal loans.
• Flexible use of funds: Many home improvement loans can be used for a wide range of renovation projects.
• Potential home value increase: Renovations may improve your home's resale value.
• Structured repayment terms: Fixed-rate options offer predictable monthly payments.

Home Improvement Loan Drawbacks

• Risk of foreclosure: Loans secured by your property use your home as collateral, so if you default on the loan, you could lose your home.
• Closing costs and other fees: Some home improvement loans may include appraisal fees, origination fees, and other closing costs.
• Qualification requirements: Credit score, DTI, and equity requirements may limit eligibility.
• Higher interest rates: Personal loans often have much higher interest rates than home improvement options like HELOCs and home equity loans.
• Longer repayment terms: Financing home improvements increases your total debt and may extend repayment timelines of current debt if you choose a cash out refinance.

Home Improvement Loan FAQs

You might still have questions before making a big financial decision if you're considering financing a home renovation. Here are answers to some common questions about home improvement loans.

Are Home Improvement Loans Tax Deductible?

Certain home improvement loan expenses are tax-deductible under specific circumstances. For example, interest and any points paid on cash out refinances may qualify for a tax deduction. Interest paid on HELOCs and home equity loans can be deducted if the funds were used to improve your home substantially.

When Should You Consider a Home Improvement Loan?

The most important factor is whether you can comfortably afford a home improvement loan. Average home renovation costs vary, and, therefore, the size of the loan you need may also vary. If you know you eventually want to sell your home, completing renovations can increase your home's value in addition to improving your quality of life.

What Is the Best Loan for Home Improvements?

The best loan depends on your financial situation, available home equity, credit score, and the size of your project. Home equity loans, HELOCs, and cash out refinances may offer lower interest rates, while personal loans can provide faster funding without using your home as collateral.

How Much Can I Borrow for Home Improvements?

Loan amounts vary based on your home equity, income, credit profile, and the type of loan you choose. Secured loans are typically based on a percentage of your home's value, while personal loans depend on lender limits and your creditworthiness. Unsecured personal loans can range from $5,000 to $100,000.

Final Thoughts: Ways To Put Your Home's Equity to Work

Freedom Mortgage offers competitive rates on cash out refinancing for conventional, VA, and FHA loans. We also offer HELOCs. The qualifying standards, interest rates, and fees for loans can vary from lender to lender, and we're proud to offer a wide variety of affordable options.

Research your options and choose the one that best meets your needs. When you're ready to explore your options and save money, you can start the application process for a cash out refinance or HELOC with Freedom Mortgage.